Crypto Basics Crypto Metrics

On-Balance Volume (OBV)

The On-Balance Volume indicator is one of the earliest tools for determining positive and negative volume flow. The volume flow (value of OBV) is calculated by adding volume on up days and subtracting volume on down days to create a running total representing the amount of purchasing and selling pressure. 

In this article, we’ll explain how the OBV works, how it’s calculated, and how to interpret it. 

What is On-Balance Volume

On-Balance Volume is used in technical trading to predict changes in the stock price depending on the volume flow. Joe Granville created OBV and published it in 1963 in his book Granville’s New Key to Stock Market Profits. One of its earliest signs was the ability to gauge both positive and negative volume flow. To forecast price changes, technical traders can use OBV to check price patterns or seek divergences between OBV and price.

Joseph Granville believed that volume is a key factor in market movement and that volume changes can predict when significant movements in the market are going to happen. He thought that when volume spikes dramatically without the stock price changing noticeably, the price will eventually rocket up or down.

How to Calculate OBV

OBV is a simple calculation that keeps a positive versus negative volume total score. If the close of a period is higher than the close of the previous period, the volume of that period is positive; if it is lower, it is negative. OBV shows if this volume is flowing into or leaving a security or currency pair. The OBV is the sum of all volumes (positive and negative). Here are the three possible scenarios to calculate OBV: 

  • If the closing price is above the prior close price: 

Current OBV = Previous OBV + Current Volume

  • If the closing price is below the prior close price: 

Current OBV = Previous OBV  –  Current Volume

  • If the closing prices equal the prior close price:

Current OBV = Previous OBV 

How to Interpret On Balance Volume 

Joe Granville said that volume comes before price. This means that price movements happen after the volume rises. When the volume on up days exceeds volume on down days, OBV increases. When the volume on down days is higher, OBV decreases. A growing OBV indicates favorable volume pressure, which may result in higher prices. On the other hand, declining OBV shows negative volume pressure, which may predict lower prices. 

The absolute value of the OBV isn’t essential to take into account. Instead, traders should focus on the trend line that the OBV is generating and compare the trend line with the security trend. Then having identified the trends, search for support and resistance levels. The OBV trend will change after a break on those resistance or support levels, and these breaks can be used as signals to enter or exit the market. 

Remember that OBV is based on closing prices as well. Therefore, closing prices should be considered when searching for divergences or support/resistance breaks. Finally, volume spikes occasionally cause a fast movement in the price that necessitates a correction, which will throw off the indicator.

Signals of bullish and bearish divergence can be utilized to predict a change in trend. The idea that volume comes before prices are the foundation for these signals. A bullish divergence is created when OBV increases or forms a higher low while prices decrease, creating a lower low. A bearish divergence is created when OBV falls or makes a lower low while prices increase, creating a higher high. Technical analysis traders should be warned that a price reversal may occur if OBV and price diverge.

Analysts use OBV volume data to follow major institutional investors. They see differences in volume and price as a reflection of the interaction between “smart money” and the dispersed masses to highlight opportunities for purchasing in opposition to unfavorable current trends. For instance, institutional capital may raise an asset’s price and sell it after other investors jump in late. 

  • The upward trend will likely continue when price and OBV make higher peaks
  • The downward trend will likely continue when price and OBV are making lower peaks.
  • If the OBV rises, accumulation may occur during a trading range, creating a warning of an upward breakout.
  • During a trading range, if the OBV falls, distribution may occur, creating a warning of a downward breakout.
  • The upward trend is likely to stall or fail when the price continues to make higher peaks, and OBV fails to make higher peaks. This is called a negative divergence.
  • The downward trend will likely stall or fail when the price continues to make lower troughs, and OBV fails to make lower troughs. This is called a positive divergence.

On-Balance Volume Indicator Limitations

The main problem with the OBV indicator is that it’s a leading indicator, producing predictions of what could happen in the market without considering what has actually happened in terms of the signals it produces. So, the main problem is that the indicator can create false signals. To reduce the risk of false signals finding OBV line breakouts, add a moving average line to the OBV. A price breakout is confirmed if the OBV indicator also breaks out at the same time.

Another problem with the OBV indicator is that fundamental analysis or institutional traders can create trading volume spikes that throw off the indicator. However, the increase in volume could not be a sign of a price trend.

The Bottom Line 

The OBV indicator using the trading volume can help you assess the trend and price of the assets. If used well, it can help you determine whether to sell or buy an asset. However, remember that you shouldn’t rely solely on one indicator to make an investment decision. There are other technical indicators that you can add to your trading plan like RSI, accumulation/distribution line, Bollinger bands, and exponential moving averages (EMAs). 

. Let’s face it, trading any market can often be a difficult and risky endeavor. This is especially true for the crypto market. Day traders, swing traders and long-term investors need all the useful information and tools they can get. Glassnode, the crypto industry’s leading blockchain data and intelligence platform, equips investors and traders with the most comprehensive on-chain insights to help them make better investment and trading decisions.

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